Unintended Consequences: Doo-gooders and Housing Bubbles

In my last post, I referred to the work of economists who argue that government policy was the cause of the housing bubble and the financial crisis. (I’ll stick with the housing bubble here, because even though they are related, they are separate issues). I often emphasize this point, not just because it is always overlooked in discussions of this issue, the economy, and the future, but because it pisses off my lefty friends who will take any excuse they can to bash free-market capitalism.

In response to my last post, fellow blogger the Real Johnson, comments: “The government didn’t just decide, ‘’hey, poor people should be able to own houses too.’” In this post, i'd like to address this point. In my view, there was a coherent policy, and it was basically well-intentioned.

I think the mechanics of the government-failure argument are pretty sound. I won’t rehash them, but you can read good overviews here, and here. When presented with this point, people often respond by trying to save the “evil capitalism” narrative as follows: it was the evil companies that corrupted government to put these policies in place so that they could make money. Now, let me say right away: I’m not fundamentally against this type of argument. There is far too much money and influence from corporations and special interest in politics, in my opinion. I don’t know of anyone who disagrees with this basic, albeit vague principle.

The question is, in this instance, which special interests and political forces were driving federal government housing policy? Was there even a policy to begin with? And if there was, were the designers intending to help poor people? The answer to the last two questions is “yes.”

The policy is clear. Bill Clinton announced his “Home Ownership Strategy” in 1995. It tries to make a case for homeownership based largely on positive externalities (economic development, dignity, financial stability crime etc…) and on inequality (fairness). Indeed, the touted benefits of the policy were: help poor people, help the community. How was the ownership strategy carried out? First, Fanny and Freddy were required to buy mortgages made to low-income buyers. Congress leaned on them heavily. Second, to make investment and ownership more attractive, tax policy was changed so that capital gains from housing were treated differently than others. Third, state restrictions on commercial lending that prevented banks from taking recourse against defaulters. Fourth, the implementation of tax deductions for mortgages. Clearly, there was a coherent policy at work. It wasn’t “deregulation” but an agenda to increase homeownership.

The second part of the issue concerns the “political economy” of housing policy. What political forces were behind this? This is a little bit more difficult to answer: but there is reason to believe that it was the forces of good, not so much the forces of evil. One lobby that pushed for cheap housing was ACORN: as early as 1992 they were pressuring banks to issue mortgage loans to (poor) people who did not qualify.
From the NY Times:

Prodded by Federal laws and an aggressive community-action group called Acorn, banks here and in other cities across the country have started making mortgage loans in neighborhoods they have traditionally avoided.

The article goes on to say:

A Federal regulator concurs. "Acorn is street-tough rough and they bedevil the bankers," he said. "But they've gotten banks to commit millions they otherwise would not have lent."

This cause was picked up by members of the Democratic Party, and pushed the center of the agenda under Clinton, and then again under Bush. Barney Frank’s role in this is well documented
He continues to deny that home-ownership policies had anything to do with the crisis, but this betrays a sort of cognitive dissonance, or a basic misunderstanding of the fundamentals (he says that home owners were not highly leveraged: but three percent down = highly leveraged). As late as 2005, he says in speech to Congress that the housing bubble is essential fake (not a bubble) and that he and his Committee would continue to push for home ownership.

This is not to say that leftwing doo-gooders were fully responsible for the housing bubble: only to say that it was caused by government policy and that it was basically well intentioned. Not many people saw this coming. Very few of the ones that did would estimate the cascading effects on the rest of the financial system and economy. But really, when housing prices are rising it’s hard to argue that everyone shouldn’t buy in. I speculate that those on the right were probably complicit in their acceptance of these policies. Indeed, if anything, homeownership and housing prices continued to rise thanks to continuation of Clinton-era policies by the Bush administration. So this is not entirely a ‘left-right’ thing, but clearly the driving force was government policy, and the intention was basically good.

In the end, IMO, the lesson is unintended consequences of government intervention. Lots of well-meaning policies have bad outcomes. This is the basic problem: knowledge. You don’t know, in advance, how people are going to react. This isn’t about science: economics is not that.